The basic economic problem

Economics begins with one uncomfortable fact: people want more than can ever be produced. Human wants are effectively unlimited, but the economic resources available to satisfy them (the land, workers, machines and ideas that go into production) are limited. This gap between unlimited wants and limited resources is called relative scarcity, and it is the basic economic problem. The word relative matters.

A resource is scarce not because there is little of it in absolute terms but because there is less of it than people would like at a zero price. Sand is plentiful on a beach, yet the construction-grade sand used for concrete is scarce relative to the demand from builders.

Because resources are scarce, every decision-maker is forced to make a choice. Choice happens at every level of the economy:

• Individuals choose between spending and saving, or between working extra hours and resting.
• Businesses choose which products to make, how many workers to hire and whether to buy new equipment.
• Local governments (councils) choose between a new skate park and resurfacing roads.
• State governments allocate a fixed budget between hospitals, schools, police and public transport.
• National governments decide how much to spend on defence, aged care or infrastructure, and how to raise the taxes to fund it.
• International bodies such as the United Nations or the World Bank decide which countries receive aid and which projects are funded.

Whenever a choice is made, something is given up. The opportunity cost of a decision is the value of the next best alternative forgone. It is not the total of everything you could have done, only the single best option you passed up. Opportunity cost is the true cost of any action, and it can be measured in money, time, goods or satisfaction.

A key idea in this topic is that benefits are weighed subjectively against costs. Two students facing the same Saturday might value it completely differently: one sees the opportunity cost of a shift at work as a missed footy game, the other sees it as a missed study session. Neither is wrong. Economists assume decision-makers compare the expected benefit of an option with its opportunity cost and choose the option with the greatest net benefit for them.

When the opportunity cost rises (for example, when wages increase), people tend to choose differently, which is why the idea is central to all later topics on demand, supply and government policy.

Finally, remember the phrase ceteris paribus, Latin for other things being equal. When economists say a rise in price lowers quantity demanded ceteris paribus, they mean they are holding every other influence constant so that one relationship can be studied in isolation. You will use this assumption constantly, so get comfortable stating it explicitly.